What effect do target-date funds have on 401k plan participants’ asset allocation? Aside from “set it and forget it,” how do workers behave when choosing from an investment menu?
TIAA Institute set out to answer these questions (and more), with the help of Northwestern University and the University of Iowa.
“Defined contribution retirement plans increasingly use target-date funds as the plan investment default with the intent of simplifying participant choices,” according to a new paper from the institute titled The effect of default target date funds on retirement savings allocations. “Many plans also have a larger number of investment options than in the past.”
It analyzed the effect of these investment menu changes on participant contribution allocations and equity exposure using a cross-section of more than 600,000 TIAA participants.
The findings?
Participants in plans without target-date fund defaults:
- Most had money market defaults
- Participants then largely switched away from the default fund
- Participants had substantial variation in equity exposure, allocating to a median of three funds
- Women also had less equity exposure than men, and contributed to more funds
- Participants contributed to more funds if the plan offered more funds.
Participants in plans with target-date fund defaults:
- More than two-thirds invested in a single fund
- Both sexes held more in equity
- Women held fewer funds and the same average equity as men
- The “size effect” of the menu was insignificant.
The authors also touch on an important policy issue, although it’s not fully vetted in the paper, which is the decline in equity percentage over time.
“A rigorous analysis of investment policy in the retirement portfolio must consider both assets held outside the retirement portfolio as well as the effects of future labor income and the correlation with asset returns,” the authors conclude, adding that research finds low market returns reduce the value of savings, which increases the relative value of future labor income.
An increase in equity exposure in the fund following a market decline “might therefore be optimal.”